Should I Finance a Large Purchase?

“Buy today with no money down and zero interest!”

You’ve seen the ads when shopping for new furniture, household appliances or an entertainment system. The text differs slightly each time, but each ad offers the same thing: the option of spreading the cost of your purchase over several months or several years, with a zero-percent interest plan. To fund your purchase, you may need to enroll in a payment plan with the company, sign up for its credit card or open an unaffiliated credit card offering an introductory no-interest period. It sounds like a fantastic deal—but is it really?

Here are the potential pitfalls of going this route and the surprising benefits of financing a large purchase under specific circumstances—even if you have the cash to pay for it today.

What happens when you finance a purchase?

Setting up a payment plan for a purchase or charging it to a no-interest credit card essentially means pushing off the payment of the purchase and spreading it over several months or even years. The retailer is eager to offer you this plan because it makes you more likely to overspend and buy something you can’t afford. Consumers love these deals because it enables them to divide a large purchase into bite-size pieces.

When is financing a bad idea?

In general, it’s not advisable to buy something you can’t really afford. But what if the total price of the sofa is prohibitively expensive and you can easily pay the monthly installments?

Here’s where it gets tricky. First, it’s important to note that nearly every no-interest offer is only temporary. Once the promotional period runs out on these deals, you’ll almost always be hit with a double-digit interest rate. Second, most of these plans come with a deferred-interest clause stipulating that any missed payment will be charged with retroactive interest after the no-interest period is over. Both of these caveats mean that missed or late payments will cost a lot more than you may believe.

With this in mind, it’s best not to finance a large purchase if any of these apply:

• Finances are extremely tight. If you regularly have trouble making it through the month, you’ll likely find it difficult to meet the monthly payments on this purchase.
• You are not a careful spender. If you technically have the money for the monthly payments, but you know you tend to blow your budget, you’ll be better off skipping a financed purchase.
• You don’t have an emergency fund. If you can fit the monthly payments into your budget, but you don’t have any cash set aside for emergencies, you might not want to finance a purchase. If you do go forward with it, any unexpected expense that arises could throw your budget off and cause you to miss one or several payments.

When financing can work in your favor

In certain circumstances, the smarter choice may be financing a large purchase you can actually pay for today. In these cases, you are confident you have enough money in your monthly budget to meet the monthly payments and you have the discipline not to spend that money elsewhere.

Here are two reasons you may want to finance a purchase you can pay for now:

1. To boost your credit rating. If you’re working on improving your credit score, adding a payment plan, also known as “installment credit,” to your credit file can help boost your score. This will only work with a payment plan since retail credit cards opened to fund a specific purchase generally only cover that purchase, which increases your credit utilization rate and hurts your score. In addition, a credit card won’t help diversify your credit file. It’s also not a good idea to go this route if you’re planning on taking out a large loan in the near future. Opening a new line of credit now may hurt your score in the short term, which will lower your chances of getting the best possible terms on the bigger loan.
2. To invest your cash in a high-yield account. If you have the cash saved up for a large purchase and are offered a no-interest payment plan that you know you can afford, you may want to invest that money (where it will be earning more) instead of using it to pay for your purchase. Remember: This can only work if you are absolutely sure you will be able to meet the monthly payments on time.

Whether you choose to finance a large purchase ultimately depends on your financial reality, personal discipline and personal preferences. Be sure to consider every angle of this decision before making a decision.